BEIJING (CAIXIN GLOBAL) - An anti-graft storm is sweeping China's semiconductor industry that is at the heart of the country's quest for self-sufficiency in technology.

Since mid-July, several senior executives connected to China's largest semiconductor industry investment fund and a high-profile chipmaker have been placed under investigation, sending shockwaves through the industry.

The probes have brought down Ding Wenwu, the president of the China Integrated Circuit Industry Investment Fund, Lu Jun, a former head of the fund's sole manager Sino IC Capital and several others. A graft scandal has also rocked Tsinghua Unigroup, the biggest recipient of the fund's support with former company chairman Zhao Weiguo and two other executives detained by authorities.

Known as the "Big Fund," the China Integrated Circuit Industry Investment Fund was a central part of Beijing's national blueprint to develop a homegrown industry and came into being long before Washington's sanctions on Huawei Technologies and others.

Set up in 2014 as China's largest industry investment fund, it initially raised over 130 billion yuan (S$26.1 billion) of capital from deep-pocketed state investors like the Ministry of Finance, China Tobacco, and China Mobile, as well as the China Development Bank, with the goal of nurturing a domestic chip industry.

After the first round of funding was exhausted by the end of 2018, having been invested in over 60 domestic companies with businesses related to chipmaking, the fund raised a second round of capital totaling over 200 billion yuan in 2019.

Over the years, the Big Fund has built up a sprawling portfolio through direct and indirect investments, backing the growth of industry leaders like Semiconductor Manufacturing International Corp. (SMIC) and Hua Hong Semiconductor.

It currently holds stakes in 34 listed companies while operating as a fund of funds by investing in other semiconductor-focused investment institutions such Oriza Holdings and SummitView Capital. It also holds a stake in financial leasing company Sino IC-leasing Co., through which it provides debt financing for companies in need of quick support with liquidity.

Industry experts said the Big Fund has played an indispensable role in cultivating China's domestic chipmaking industry by providing stable funding and state endorsements to fledgling businesses that struggled to access capital elsewhere.

"The investment cycle of the chip industry is very long and requires a huge amount of money. Market-based funds may be hesitant to invest," said a chip company executive. The Big Fund offered needed support from the state level, said the person.

The series of scandals, however, have sparked questions over the fund's efficiency and future value. Criticism has mounted over the past few years after several high-profile projects the fund invested in ran into trouble, including the bankrupt Tsinghua Unigroup. Some argue that the mission of the Big Fund has largely been completed, and it is time to leave the market to local government-backed funds and private investors.

But other experts said it still has a role to play, especially as major economies such as the United States and the European Union have stepped up government support to their domestic chip industries after last year's global supply shortage.

Added to this is the fact that many Chinese semiconductor companies are still fledgling and not yet profitable. They face challenges simply to survive and assistance from the Big Fund will help them break through bottlenecks and grow more steadily, said Li Hongtao, chief telecom industry analyst at Founder Securities.

The Big Fund has set up an unprecedented model by combining state strategy and a market-oriented investment approach, which has inspired many other funds, said a venture capital manager. What it needs is to improve the system and governance to prevent corruption, said the manager.

Anti-graft storm

The storm that has rocked the Big Fund started in mid-July when the Central Commission for Discipline Inspection (CCDI) announced an investigation into Lu Jun, former head of Sino IC Capital.

Lu, 54, headed Sino IC Capital - the company that manages the Big Fund - from its inception in 2014 to 2020. Lu took a senior job at China Development Bank (CDB), the nation's biggest policy lender, after he left the Big Fund in November 2020 until last September when he became president of Guangzhou Bay Area Semiconductor Industry Group. Caixin learned that Lu was taken away by authorities on July 14 and on the same day, Wang Wenzhong, partner of a subsidiary fund and a close associate of Lu, was also placed under investigation.

The investigation has widened to ensnare Yang Zhengfan, deputy head of Sino IC Capital's investment division. Yang oversaw the Big Fund's investment in equipment makers and holds the position of board member at more than 10 semiconductor companies.

Then on July 16, Tsinghua Unigroup's former chairman and shareholder Zhao Weiguo was put under investigation. Zhao, who has headed the company since 2009, is suspected of pocketing personal gains from opaque procurement deals between former Unigroup subsidiaries and companies he controls, people with knowledge of the matter told Caixin.

Together with Zhao, Tsinghua Unigroup's former co-president Diao Shijing, and Li Luyuan, chairman of Unigroup's subsidiary Beijing Uni Science and Technology Service Group, have also been detained by authorities for investigation. The snowballing probe into former senior managers marks a precipitous fall for Tsinghua Unigroup, once at the forefront of China's drive to develop the domestic semiconductor industry and the biggest recipient of cash from the Big Fund.

However, it should not have come as a total surprise, as it had run into financial troubles after years of debt-fueled expansion, with the company recently completing a bankruptcy reorganization that led to an ownership change.

Then, on July 30, the CCDI, China's top graft buster, disclosed it had launched an investigation into Ding Wenwu, president of the Big Fund. Sources close to the matter told Caixin that investigators raided Ding's home just days before and the 60-year-old executive has since remained unreachable.

Both Lu and Ding were key investment strategy decision makers for the Big Fund. The fund adopted a two-tiered management structure in which the board set strategy and approved major projects, while fund manager Sino IC Capital carried out investments and managed the money. Sino IC Capital is 45 per cent owned by CDB.

Sino IC Capital can make investment decisions on ordinary projects, while the Fund's board has the final say on major projects, Ding told media in 2017. The investigation storm seemed to take some by surprise. People close to Lu said he was in good spirits right before the investigation as he had taken a new job at Guangzhou Bay Area Semiconductor Industry Group, a major investment fund backed by the Guangdong provincial government. Meanwhile, Ding was last seen in public on July 16, when he attended a semiconductor industry summit in Xiamen, Fujian province, and delivered a keynote speech.

However, others said this had been some time coming, with several sources at chip companies and investment institutions telling Caixin that the National Audit Office has launched a slew of probes into the Big Fund and recipients of its investments since September. And subsequently, a number of companies and institutions have received orders for to make rectification, sources said.

Internal flaws

There have long been rumors circulating in the industry about how Big Fund managers illegally benefited from the companies they invested in, sources said. In November 2020, Lu was transferred to CDB after numerous complaints were lodged against him and an internal investigation was launched within Sino IC Capital, said a person familiar with the matter.

One of the controversial deals was the Big Fund's 400 million yuan investment in Hunan Goke Microelectronics in 2015. Goke Microelectronics operated in the crowded market for television chips and was experiencing a slide in sales due to a price war when the investment was made. But the fund - and Ding personally - showed great support for the company. After Ding's downfall, rumors surfaced that Xiang Ping, founder of Goke Microelectronics, had also been probed. Caixin's calls to Xiang went unanswered and the company didn't reply to questions.

The massive and widening scandal partly reflects flaws in the fund's internal management, said people familiar with the fund. One of the most apparent weaknesses was the limited incentive plans, which only offered fixed salaries for its investment managers and most staffers at the fund and Sino IC Capital, sources said.

"It could be a big shock when their job created so many billionaires while they earn a salary of 10,000 to 20,000 yuan a month," said a chip company source. Although Ding told media that the fund managed its employees in line with that of a full market entity, sources said the personnel management was still rigid and more like that of a government-backed institution.

That made the jobs less attractive to capable managers. Consequently, since 2020 the fund has experienced a brain drain as competition for talent has heated up. "At least a quarter of Sino IC Capital's (original employees) have left," an executive of another state-backed investment fund said. "Many (senior managers) left with their entire team."

Future role

Despite the laundry list of woes besieging the Big Fund, some have argued that it's past performance shouldn't be discredited due to its current circumstances and that it still has a useful role to play.

"The anti-corruption campaign should not become a reason to attack the Big Fund's investment strategy and achievements," said the investment fund executive. "Its role in promoting China's integrated circuit industry should not be ignored."

The first round of 130 billion yuan in funds was used up by September 2018, with 67 per cent invested in chipmaking and the rest in design, packaging and material and equipment development. Since 2019, the Big Fund has started exiting some of these projects.

The performance during the first phase of its investments exceeded market expectations, analysts said. More than half of some 60 projects the fund invested in have gone public, generating sound returns, according to Caixin's calculations. These included state-backed strategic projects and public businesses.

Before the Big Fund, there were only a few investment funds focusing on the semiconductor industry in China and most of them only invested in chip design projects with shorter investment cycles and less risk, said the venture capital executive.

With the Big Fund's support, many fledgling chip companies overcame the industrywide financial crunch between 2014 and 2015 and grew into leaders such as SMIC and Hua Hong Semiconductor. The fund also invested in Yangtze Memory Technologies and ChangXin Memory Technologies to fill the dearth of DRAM memory production in China.

"Without the five years of development backed by the Big Fund, China's semiconductor industry would have faced more difficulties when US sanctions hit in 2019," said the venture capital executive.

One of the most successful deals was the fund's 2014 investment in loss-making Advanced Micro-Fabrication Equipment (AMEC). With an US$80 million investment combining equity and debt from the fund, AMEC survived a financial crisis and debuted on the Shanghai STAR Market in 2019.

Shares of the micro-fabrication equipment maker, which has won customers at home and aboard, are traded at 130 yuan apiece, compared with about 15 yuan paid by the fund.

The fund also backed Jiangsu Changjiang Electronics Tech (JCET)'s 2014 acquisition of Singapore's larger rival STATS ChipPAC. The deal made JECT the third-largest chip packaging company in the world. "Without the Big Fund, JCET's acquisition would be very difficult because STATS was running a loss and the capital market was not enthusiastic," said Gu Wenjun, chief analyst at high-tech research platform ICwise.

Experts have suggested the second phase of the Big Fund should involve expanding its investment cycle beyond the current five years and move further toward early-stage investment with a higher tolerance for risk.

But amid the corruption scandal, managers at the fund have shown greater caution when making investment decisions, focusing on previously invested targets or mature projects. According to CSC Financial , during the second phase, the Big Fund has invested 79 billion yuan in 38 companies, among which 75 per cent of the funds went to wafer fabrication projects.

"There has been lots of overlap between companies on the second phase investment list and the first phase, indicating that many people want to invest in the most secure companies in order to avoid trouble," said a chip company source.

Thus, the second phase of investment has become more conservative, but the requirements for recipients are now stricter, said the manager of the state-backed investment fund. Amid ample liquidity, companies are less keen to obtain money from the Big Fund, he said.

Since the establishment of the Big Fund, a large number of smaller funds focusing on the chip industry have been created by local governments and private investors keen to get in on the action in the booming market, thus offering greater access to funding to industry players. The more diverse market and recent crackdown on the Big Fund have sparked concerns that the state may reduce its support for the semiconductor industry.

Ye Tianchun, director of the Institute of Microelectronics of the Chinese Academy of Sciences and the chief scientist directing China's chip equipment development, said the state support to the industry remains unchanged.

"Chip, like steel, is the most important basic technology that requires decades of investment," said Ye. "The state strategy is determined and will not change."

This story was originally published by Caixin Global.